Most people with children take into account the financial implications of their care — for instance, they prioritize paying for their children’s food, shelter, clothing and education. But they might not even consider the fact that taxes can affect minors, too. Parents should familiarize themselves with the tax implications of the “kiddie tax,” hiring their children and setting up IRAs for working teens.
How the kiddie tax works
The kiddie tax was created to prevent wealthier parents from shifting unearned income, such as dividends and interest, to their kids, who usually enjoy lower tax rates.
To that end, if a child — typically, under age 18 or a full-time student under age 24 at the end of the tax year — has unearned income totaling more than $2,100 (for 2017), some of the income may be taxed at his or her parents’ rate, if it’s higher than the child’s.
If the child’s unearned income in 2017 is more than $2,100 but less than $10,500, the parents may be able to include the income on their return, and skip filing a return for their child. Bear in mind that doing so bumps up the parents’ income, which could impact certain deductions or allowances based on AGI.
Having children work for you
Hiring one’s kids to work in a small business can help instill a work ethic, while the children handle tasks that otherwise might go undone. However, parents considering this must follow a few guidelines. For example, the child should be old enough to handle the responsibilities assigned. He or she should perform real tasks and be paid an appropriate wage. While it may be tempting to hire a child at an exorbitant salary — even if the job’s duties consist of making copies or opening mail — because his or her tax bracket probably is lower than the parents’, the IRS frowns on this practice.
Know the rules: Say the business is a sole proprietorship or partnership in which each partner is a parent of the child, under age 18, who’s working in the business. The child’s wages won’t be subject to Medicare and Social Security taxes.
If the business is a corporation or estate, however, the child’s wages are subject to income tax withholding, as well as Social Security, Medicare and federal unemployment taxes. That’s true even if the child’s parent controls the corporation.
Not too early to start saving
Although retirement is decades away for teenagers, they’re not too young to start saving for it. Given the time value of money, even modest amounts put away from part-time jobs can snowball into a sizable sum by the time teens are ready to tap into the funds. Consider this: $2,000 deposited in a retirement account earning 5% will be nearly $23,000 50 years later, even if no other amounts are deposited. Moreover, having a retirement account can help teens get in the habit of saving money.
Bear in mind that, in order to contribute to an IRA, the teen must have earned income, either in the form of W-2 wages or other compensation. Roth IRAs can be of particular value, especially in situations where the teen’s income isn’t enough to generate any income tax. For 2017, contributions, whether to a Roth or traditional IRA, are limited to the lesser of $5,500 or their taxable compensation for the year.
Typically, the account will need to be opened and held by an adult in the name of the child. When the child reaches age 18 or 21, depending on the state, he or she can assume ownership.
Navigating the system
There is a lot of nuance to the tax issues surrounding children. Your tax professional will be able to provide a road map for navigating the labyrinth.
This material is generic in nature. Before relying on the material in any important matter, users should note date of publication and carefully evaluate its accuracy, currency, completeness, and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances.